Friday, 11 June 2021

Whoopee: New Economics Foundation will research a problem solved long ago.



Details are in an article on the Brave New Europe site entitled  “We don’t need cuts to pay back pandemic debt.” The author is NEF researcher Dominick Caddick.

One of the central claims in the article is that a rise in interest rates would not matter for government finances because the Bank of England can always buy up debt and pay less interest to the resulting holders of reserves at the BoE, or indeed pay them no interest at all. See the two paras starting “In addition a side effect….”  

Thus, so the article claims, “So even if interest rates were to rise, there would be many options for the Bank to make it more manageable (a subject of future NEF research).”

Well simply saying there are many options does not tell us exactly what government and central bank (henceforth “the state”) need to do given a rise in interest rates. And the fact that the NEF is apparently going to “research” this topic indicates that Caddick doesn’t know what to do for the best in different circumstances. But never mind: the solution was worked out long ago on this blog and by MMTers and others. I’ll assume first that public spending as a proportion of GDP is to remain constant. The solution is thus.

First possible scenario is that continued significant stimulus is needed. In that scenario the liklihood is that all the state needs to do is create money and pay off debt as it matures. The fact that interest rates have risen indicates a reduced willingness on the part of creditors to hold large amounts of base money without being offered a reward in the form of an elevated rate of interest for doing so. And that by definition means those creditors if not offered that reward will tend to try to spend away what they regard as their excess stock of cash / base money / reserves, and that equals a rise in demand, which is exactly what is needed. So no problem there. That attempt to spend away is sometimes referred to as “the hot potato effect”. (Any readers wishing to claim that only commercial banks hold reserves, please see appendix below.)

A second possibility is that little or no stimulus is needed. In that case, obviously the latter rise in demand is a problem.  So what to do?

Well obviously if no extra demand is needed then the latter “spend away” is a problem. But like all instances of excess demand, that can be dealt with via cutting the deficit (i.e. raising taxes and/or cutting public spending).

But note the sole effect, or at least intended effect, of that cut in the deficit, is the damp down that excess demand. Ergo there ought to be no effect on GDP or living standards.

Problem solved.

As for where there’s a rise in the proportion of GDP going to the public sector, that is easily achieved simply by raising taxes and public spending by about the same amount.

Examples of articles were I dealt with the above points several years ago include an article at the MPRA site entitled “Consolidation causes little austerity” and also this article on this blog.


Appendix. Do only commercial banks hold reserves?

It might seem that way, but actually the claim that only commercial banks hold reserves is misleading for the following reasons.

Governments and central banks create base money and spend it into the economy when stimulus is needed, something they’ve done on an astronomic scale over the last ten years. Recipients of that money bank it, and relevant banks credit the accounts of those recipients and then lodge the money at the central bank, where such money is referred to as “reserves”.
But note that the latter “recipients” have control of that money. That is, if I draw a cheque on my account at Barclays and pay someone who banks at Lloyds, Barclays will have to transfer reserves to Lloyds (and of course the person who banks at Lloyds sees their account credited by Lloyds). So even though I don’t have an account at the BoE, it’s very much “little old me” who in in control of my little stock of reserves.

Put another way, I control my little tranche of reserves at the BoE: it’s just that my commercial bank acts as my agent when I deal with the BoE.

Of course I can also go to an ATM and demand that £X of my reserves are turned into actual physical cash. When I do that, Barclay’s stock of reserves at the BoE will fall by £X. There again, I am very much in control.

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